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Stability

Why the Indian bond market remained unruffled by the S&P's rating downgrade.

By Ashish Gupta

Rupee bonds: Unscathed

Everybody heard about it, with their eyebrows raised to various degrees. Those who didn't hear about it, or pretended that they didn't, or couldn't care less even if they did, were India's bond traders - the chaps at whom the S&P's rupee debt downgrade was aimed.

Not that it wasn't alarming. Whatever the technicalities, whatever the justifications, or lack thereof, the term 'junk status' sounds exactly how it's meant to sound - bad.

And the reasons cited -- mounting debt and weakening finances of the public sector - were not news to any well-aware Indian either.

Yet, the Indian market for bonds has remained a picture of calm, with traders whistling through their regular trading day... with bond yields barely rising a few basis points (each basis point is a hundredth of a percentage point), before settling down to normal (low, that is) levels again.

So, what's up?

The biggest reason for the non-reaction is that the country's economic circumstances, particularly on the fiscal front, have long been factored into the capital markets. One would have to go to Mars to find a bond trader shocked by the state of Indian public finances. Besides, it's high highly unlikely that the Indian government will default on its debt (unless circumstances take an unimaginable turn for the worst). So the rating, to that extent, is merely notional. A sort of warning flash, a piece of information, rather than anything else.

But surely, the downgrade must affect somebody's investment portfolio? Don't institutional investors have guidelines on asset quality?

Well, as S. Naren, Head of Research, HDFC Securities, points out, such downgrades tend to sway foreign institutional investors (FIIs), and the extent of their investments in government bonds (some $500 million worth) is too small to make a difference to overall market conditions. Even if the FIIs were to offload all their holdings, the government can easily absorb the same.

The other reason that Naren furnishes is the sheer absence, in the domestic context, of any worthwhile place to park funds. The stock markets are down in the dumps, and there are few other avenues. Excess money that gets stacked up ends up in government bonds (ask commercial banks). And why not? It's still the best paper going, so regardless of the rating on India's sovereign rupee debt, the money stays put.

Dhirendra Kumar of Value Research is in broad agreement with Naren. Since only the sovereign rupee debt has been downgraded to 'junk' status by S&P, and rupee bond traders are all within the domestic system, the move has had no effect on the actual bond market. What matters is the government's interest rate policy, and so long as it favours low rates, bond yields will remain low (the spread between government and private bonds is quite low too, these days). And if public finances are on such shaky ground as to prove catastrophic one fine day, then there's little that bond traders can do to shore themselves up anyway. Might as well shrug and carry on.

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